A Turn in the Credit Cycle
by Scott Minerd
November 28, 2012
Investors should understand the recent transition in the credit market and the implications it could have for the trajectory of asset prices over the long-term.
Credit spreads keep ratcheting down as the bull market in credit continues. Bull markets typically have three legs. The first is what I call disbelief, which is what we went through in March 2009. This is when assets are so depressed from widespread liquidation that when selling pressure eases, prices rise. The next leg is the fundamental leg when improving fundamentals, such as falling default rates and lower inflation, drive the appreciation in prices. The third leg is a period of overvaluation. This stage often runs further and lasts longer than investors expect.
The high yield bond market appears to be moving from the fundamental leg to the overvalued leg. A greater portion of investment activity in the high yield market is now based on investors simply wanting to own the asset class. As a result, it has become harder to find the same level of value previously experienced in the below-investment grade market. While there is still a fair amount of room for spreads to tighten further, investors should be aware of the shift in the environment and adjust investment decisions accordingly.
Economic Data Releases
U.S. Consumer Sentiment is Rising on Moderately Better Economic Data as We Enter the Holiday Season
Total sales from the four-day Thanksgiving holiday weekend were 17% higher than a year ago, a positive sign of consumer sentiment as we enter the holiday season. U.S. consumer confidence edged up to 73.7 in November, a four-year high. Regional sentiment indices were mixed, with the Richmond Fed rising above zero but the Philly Fed and Empire Manufacturing indices both remaining below the level that signals contraction. On the back of positive housing data last week, the FHFA home price index rose again in September by 0.2% following an increase of 0.5% in August. Durable and capital goods orders also reported better than expected results for October. Durable goods orders were flat for October, which was better than expected. Capital goods orders excluding aircraft climbed 1.7%, far exceeding expectations.
Manufacturing in Europe Appears to be Stabilizing Despite Worsening Consumer Sentiment
A number of Manufacturing PMI Indicators across Europe seem to suggest the slowdown in industrial activity may be beginning to stabilize. The Eurozone PMI composite edged up in November to 45.8 from 45.7 in October. Manufacturing PMIs for both Germany and France increased in November. The IFO Business Climate index for Germany also rose to 101.4 in November, the first increase in eight months. However, consumer sentiment in Europe has worsened with consumer confidence in Germany falling to 5.9, the lowest level since August. Consumer confidence in Italy fell to 84.8, the lowest level since data became available in 1996. Industrial activity turned positive in Asia, where China’s HSBC Manufacturing PMI rose to 50.4 in November, the first expansion in 13 months. Additionally, Singapore’s industrial production rose 3.3% in October, the fastest growth rate since June 2012.
Chart of the Week
High Yield Debt Issuance by Use of Proceeds
Strong primary issue demand and low nominal rates have driven the high level of recent debt refinancings. Since 2010, over $450 billion in bank loans and high yield bonds have been refinanced. While there has been nearly $750 billion in bond issuance over the last three years, 60 percent has been used to refinance existing debt. Net new supply has been minimal with the high yield market growing only 16 percent since 2010.
Source: Barclays. Data as of 9/28/2012.
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